Nick Clegg, the deputy prime minister, warned the government's housing minister, Grant Shapps, that council cuts in Sheffield were resulting in "dramatic cuts to services [for] excluded people" as demands increase because of the "current economic situation", according to letters obtained by freedom of information requests.

Nick Clegg wrote to his junior colleague earlier this year concerned that not only was the amount of money being reduced for the Supporting People budget – the Treasury pot of money paid to councils to enable them to help vulnerable people to live independent lives – but that local authorities were also no longer obliged to ring fence the cash for the poor.

Supporting People budgets, introduced by Labour in 2003, are supposed to be used for housing support for homeless people, older people, drug and alcohol users, ex-offenders, and those with mental health or learning disabilities. The coalition government says that the £6.5bn four-year budget has only been subject to a yearly 1% cut, but there is evidence that the budget is being raided to fill the hole left by cuts on other parts of the council budget.

The result, in correspondence obtained by Inside Housing magazine, sees Clegg warning that "many local authorities are not using the fund for the intended purpose and this is resulting in dramatic cuts to services".

The deputy prime minister also says that there is a "concern that organisations with no knowledge of the needs of vulnerable groups will now tender for contracts and undercut on price and quality of provision".

Sheffield council had outlined plans for spending cuts totalling £80m this year. This figure would rise, it warned in March, to more than £200m by 2015.

The deputy prime minister, writing in his capacity as local MP for Sheffield Hallam, said that in his constituency housing associations would like to see the council reinstate the Supporting People ring fence. His letter also raised concerns about plans to pay the new universal credit directly to tenants instead of to landlords.

The reply from Shapps is cordial but firm. The housing minister replied to Clegg on 18 May in a letter which stated: "There are no plans to reinstate the Supporting People ring fence."